Dark Clouds on the Horizon for Boeing


When Boeing reported its fourth-quarter and annual results on Jan. 30, CEO James McNerney tried to stress the good news, of which there was plenty: more orders, more deliveries, more revenue, more profit. By the numbers, it was a terrific quarter and year for the jet maker. Most eyes, however, are affixed to two bad news stories. Most obviously, the 787 fleet remains out of commission as investigators try to get to the bottom of their mild "catching-on-fire" problem, while within the company, tensions between management and engineers are coming to a head.

First, the good news. Sales grew 14% for the fourth quarter and 19% for the year, largely driven by increased deliveries of pricey wide-body aircraft. Core operating earnings (adjusted for a tax settlement in 2011) rose 9% and 13% for the quarter and year, respectively. Strong order growth and delivery execution in the year also allowed Boeing to regain the top spot as the largest aircraft manufacturer, which in recent years has been occupied by Airbus.

Boeing also continued the strategically important pivot away from defense and toward commercial airplanes, ending the year with over 60% of revenue coming from commercial planes. Boeing's order backlog continued to grow in 2012, and portends an even stronger reliance on commercial planes: At $319 billion, commercial planes make up over 80% of the $390 billion backlog.

On the other hand, as we've discussed before, the delivery of new wide-body planes like the 787 drives gross margins down initially because the first block of sales goes toward repaying development costs rather than the bottom line. As a result, operating margins for both the quarter and the year slipped slightly.

Sparks on a plane
Of course, all this positive financial news is undercut by the well-publicized global grounding of the 787 Dreamliner, a plane that more than any other holds Boeing's future. On the earnings call, McNerney assured analysts that the company was cooperating fully with the FAA investigation and that getting the Dreamliner back on track was the company's top priority.

However, he reiterated that the production schedule for the 787 was unchanged, indicating a belief that battery problems will be trivial to solve and the manufacturing process won't need to be changed. I would note, here, that McNerney was similarly confident that failures on the 787 wouldn't affect the airworthiness of the plane, dismissing problems as "normal squawks" shortly before the entire fleet was deemed unsafe to fly. I continue to expect significant obstacles in scaling up production in order to meet demand.

No nerds, no birds
Even more worrying is the growing friction between management and engineers. Boeing wants to transition new hires away from a defined benefit pension plan and into a defined contribution plan, and this is sensible. Nobody can make absolute guarantees about the future, and employees should take some responsibility for their own retirement.

However, Boeing has gone too far. When the engineering and technical workers' union contract expired in November, Boeing's new offer was frankly insulting. After a year in which Boeing's engineers had finally pulled off the delivery of the most technologically advanced plane ever made - an achievement for which McNerney himself received a 34% raise - Boeing offered its engineers and technical workers raises between 2% and 3%, compared to the previous contract rate of 5%. It astounds me that McNerney thinks his own work became 34% more valuable, while the people who actually built the plane should get "rewarded" with a worse contract.

Unsurprisingly, the union took this as a slap in the face, and rejected the contract. Boeing has upped its offer several times, out of necessity, and is now offering the 5% raise that the union wanted in the first place, but through its heavy-handed bargaining position the company has not only alienated, but actually infuriated, the union. Union members refused the contract almost unanimously, even demonstrating against Boeing management using the slogan "no nerds, no birds." Union members are currently voting on a strike, which could be approved as soon as Feb. 19. Despite denials by management, I believe a strike would assuredly prevent the company from executing its planned production increase and drag the investigation into the 787 battery problems to a halt.

More generally, Boeing's strength as a company stems entirely from its people. Boeing doesn't just need happy, working engineers to solve the battery problem, it will need them for big jobs like completing design of the 787-9, creating the 787-10, reengineering the 777 - really, creating any new product it ever wishes to make. At it's heart, Boeing is nothing more than the efforts of its engineers. McNerney has said that his top priority is fixing the battery problem, but that's nonsensical because, of course, he can't do that himself. His - and Boeing's - top priority needs to be keeping the talent happy. That they're not doing so should worry investors.

Boeing has a multitrillion dollar market opportunity ahead, but the company's execution problems, as well as emerging competitors, raise questions over whether Boeing will live up to its shareholder responsibilities. In this premium research report, two of The Motley Fool's best minds on industrials have collaborated to provide investors with the key, must-know issues around Boeing. They'll be updating the report as key news hits, so make sure to claim a copy today by clicking here now.

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